April 15 (Bloomberg) -- Borrowing costs for China’s
Ministry of Railways are surging this year amid concern the
builder of the world’s biggest high-speed network will struggle
to repay 1.8 trillion yuan ($275 billion) of debt.

The company sold 50 billion yuan of bonds this year, more
than Indian Railway Finance Corp. and Russian Railways offered
in 2010, and has more than 120 billion yuan of principal and
interest payments due in 2011, according to data compiled by
Bloomberg. The yield gap between its one-year notes and
government debt more than doubled to 125 basis points on April
12 from 56 on Dec. 31, according to Chinabond data, the widest
since September 2008 when Bloomberg started compiling the data.

The relative yield for bonds sold by the ministry, rated
AAA domestically at the same level as the sovereign, which is
ranked AA- by Standard & Poor’s, is wider than debt sold by
billionaire Warren Buffett’s Berkshire Hathaway Inc.-controlled
Burlington Northern Santa Fe that’s rated four levels lower at
BBB+, according to data compiled by Bloomberg. China plans to
spend 2.8 trillion yuan in the five years to 2015 on railway
infrastructure to help sustain economic growth.

“The railway ministry cannot pay” its debt, said Zhao
Jian, a professor at Beijing Jiaotong University, which can
trace its origins to China’s School of Railway Management in
1909. “The central government will. This will happen within the
near future, within the next five years,” he said.

Losing Steam

China’s new rail chief yesterday ordered high-speed bullet
trains to run at slower speeds to help lower fares, according to
spokesman Wang Yongping. The ministry didn’t respond to
telephone calls and a fax from Bloomberg seeking further comment.

The spread on the ministry’s 3.88 percent bonds due in 2020
over similar-maturity government notes reached 101 basis points,
or 1.01 percentage point, yesterday, from a 66-basis point gap
when the security began trading in September, Chinabond prices
show. The 3.6 percent bonds due in 2020 sold by Burlington
Northern Santa Fe yielded 83 basis points more than Treasuries
yesterday, according to Trace, the bond price reporting system
of the Financial Industry Regulatory Authority.

“Repayment is going to be an issue sometime down the road
when the financial situation worsens further,” said Karen Li,
the head of infrastructure research at JPMorgan Chase & Co. in
Hong Kong. “They still have a lot of capex commitments over the
next few years” as many projects are incomplete, she said.

The nation’s new rail minister Sheng Guangzu pushed for the
speed clampdown, said a China Daily report citing an interview
with the minister. A speed cut will pare operating costs as a
train running at 350 kph can use twice as much energy as ones
going at 200 kph, the state-run newspaper said, citing Beijing
Jiaotong’s Zhao.

Railway Spending

Railway spending totaled 1.42 trillion yuan over the last
two years, 33 percent more than was invested in the previous
five, according to data compiled by Bloomberg. China plans to
add as much as 30,000 kilometers of new track before 2015 to its
91,000-kilometers network, the People’s Daily reported April 13,
citing Minister Sheng.

The state rail operator received 428.9 billion yuan in bank
loans under China’s financial stimulus package in 2009 to buffer
the nation against the impact of the financial crisis. Fiscal
stimulus helped fuel inflation and the People’s Bank of China
has raised interest rates four times since the third quarter to
help drain excess liquidity from the financial system.

The cost of five-year credit-default swaps protecting
Chinese government bonds from default was largely unchanged at
71 basis points yesterday, down from this year’s high of 80 in
January, according to data provider CMA.

Default Swaps

Credit-default swaps insure debt against non-payment, and
traders use them to speculate on credit quality. A drop signals
improving perceptions of creditworthiness, while an increase
suggests the opposite. London-based CMA is owned by CME Group
Inc. and compiles prices from hedge funds and other clients.

The yuan, or renminbi, is forecast to gain the most this
year among the currencies of the so-called BRIC economies,
according to median forecasts in Bloomberg surveys.

The currency has gained 0.06 percent this week to 6.5317
per dollar as of 12:58 p.m. in Shanghai, according to the China
Foreign Exchange Trade System, after touching 6.5290 earlier
today, the strongest level since 1993.

Twelve-month non-deliverable forwards were little changed
at 6.3850 per dollar as of 1:04 p.m. in Hong Kong, reflecting
bets the yuan will gain 2.3 percent, according to data compiled
by Bloomberg.

Credit Line

The ministry has been promised a bank credit line of as
much as 2 trillion yuan from domestic lenders, according to a
recent bond prospectus. It borrowed 250 billion yuan from China
Development Bank Corp, the state-owned policy lender, during the
last five-year national economic plan which ended in 2010,
according to the bank.

“They can borrow new loans to repay old loans, that’s how
it’s operating,” said Zhao, adding that new rail services may
not attract enough passengers to meet targets. “It can’t go on
like this.”

The rail operator’s 120 billion yuan in bond principal and
interest payments due by the end of this year is more than 40
times its net income of 2.7 billion yuan in 2009, the latest
data compiled by Bloomberg show. A railway construction fund set
up by the government provides 50 billion yuan a year, according
to Zhao.

China may be forced to form a company to absorb all of the
ministry’s debt within the next five years to avert default,
said Zhao. The ministry may be restructured with all its “good
assets” placed into a company that will be sold to investors
via an initial public offering, according to JPMorgan’s Li.

“Their refinancing ability is very strong,” Zhang Jun, an
analyst at China Chengxin, said from Beijing. “Liquidity may be
weak, but the ministry depends on refinancing, not cash
generated from the operations.”